Unit 3 Revision ALEVEL

8/20/2019 Unit 3 Revision ALEVEL

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Unit 3 BusinessEconomics & Economicefciency

Competition Policy, Regulation and

Contestability



Unit 3 Business Economics &Economic efciency

The exam

ContestabilityCompetition Policy

PriatisationRegulation



!" The exam #

# $%UR 3 '()UTE* +%)- ./ !0

- T%T!+ 10 '!R2*

Supported choice:

8 questions for 4marks each

Total 32 marks

Spend no longer than40 minutes here

Data question: / ealuation

4 questions

Total 40 marks

Spend 50 minuteshere



!" The exam 0

The supported choice4

5e6nition4 # mar7

5iagram4 # 8 3 mar7s

!nnotation4 # mar7

!pplication9calculation4 # 8 0 mar7s :urther analysis4 # 8 0 mar7s

2%s 8 # 8 0 mar7s



!" The exam 3

The data response4

. mar7 ;uestion▪ purely knoledge and application marks

▪ remem!er to apply your knoledge to theindustry in the e"tract

< mar7 ;uestion▪ 4 marks for identi#cation$ e"planation and

analysis

▪ 4 marks for e%aluation & 2 good e%aluation points



!" The exam .

The data response4

#0 mar7 ;uestion▪ De#nition'knoledge & ( mark

▪ )pplication$ analysis * diagram & 5 marks

▪ + marks for e%aluation

#= mar7 ;uestion▪ 8 marks for identi#cation$ e"planation and

analysis

▪ 8 marks for e%aluation & ,2 - 2 - 2 - 2. safest



B" Contestability



B" Contestability #

! per>ectly contestable mar7et hasno sun7 costs ?entry and exitbarriers@ and per>ect in>ormation?thus only normal pro6ts areearned@

/ontesta!ility a #rm1s potential too%ercome sunk costs and enter themarket and so share in its supernormalpro#ts



B" Contestability 0

*un7 costs costs that a #rm mustincur to enter a market and areirreco%era!le if the #rm su!sequentlye"its

arkets ith high concentration$ and the

potential for a!use of monopoly poer$may not need regulation if the Tconsiders them contestable ith loe"it costs



B" Contestability 3

Ahat are the determinants o>contestability

(6 Technological change26 7atural monopoly36 conomies of scale

46 9randing * ad%ertising le%els56 imit pricing+6 ;nformation asymmetry<6 =ights to distri!ution or ra materials



B" Contestability .

;n 200+$ /oca/ola launched a sugarfreesoft drink called >/oke ?ero@ and spent A8mn on ad%ertising the !rand6 Bhich of the

folloing is most likely to make it diCcult forother #rms to enter the soft drink market

) The a!sence of consumer loyalty for /oca/ola6

9 Eigh sunk costs6

/ Strong go%ernment las on anticompetiti%epractices6

D Eigh le%els of contesta!ility6

) lo concentration ratio6



B" Contestability

The !onuses to customers a%aila!lethrough supermarket loyalty cards$ suchas those oFered !y Tesco * Sains!ury1s$are likely to make the industry:

) ess integrated

9 ess contesta!le

/ ess concentratedD ess pro#ta!le

ore contesta!le



B" Contestability =

;n Gune 2005 the uropean /ommissionreported that /oca/ola imposed e"clusi%ityagreements ith retailers to stock their soft

drinks6 ) moti%e to act in this ay is to:) increase the choice of soft drinks6

9 o!tain !ene#ts from horiHontal integration6

/ di%ersify into unrelated markets6

D o!tain !ene#ts from %ertical integration6

reduce concentration in the soft drinks market6



B" Contestability 1

Example – Japanese electronics (Economist 11/09)

Gapanese companies ser%e <0I - of the orldide market in 30- technology sectors orth more than J( !illion apiece6 Gapan1schampions share certain characteristics6 They in%est handsomelyin =*D6 They often on their supply chains and some #rms e%enmake the %ery machines they use$ in order to control costs$remain independent of suppliers and maintain a deepunderstanding of their technology6 The components$ tools andmaterials in hich Gapanese #rms e"cel are highly customised6 ;t

is only !y orking closely ith clients o%er many years thatsuppliers gain insight into their future technical plans and aretrusted to learn a!out thorny pro!lems that a cle%er suppliermight sol%e6 oreo%er$ the knoledge cannot !e transmitted !yreading a patent !ut accumulates !y orking ith colleagues o%ermany years6



B" Contestability <

To hat extent is this mar7etcontestable

De#ne contesta!ility%idence: Bhat are the sunk costs

;s there asymmetric information

Bhat are the le%els of pro#ts

)re any #rms poised to enter

;f there1s a regulator$ it suggests it1s uncontesta!leK



B" Contestability D

To hat extent is this mar7etcontestable

%aluation:

)rgue the opposite ay & it iscontesta!leLL6

agnitude of factors & use e"tract'data

;s contesta!ility changing in the longrun



C" Competition Policy



C" Competition Policy #

The %fce o> :air Trading, %:T4Mromote competition * protect the

consumer interestMre%ent a!use of monopoly poerMre%ent restricti%e practices=efer in%estigations to /ompetition

/ommission=egulate industries



C" Competition Policy 0

The %fce o> :air Trading, %:Tpoers4

ines up to (0I NO annual turno%er ;mprison directors for up to 5 yearsnter and search !usinesses for

e%idence9lock mergersBhistle !loing rearded




The Competition Commission4 ;n%estigate mergers P 25I market share ;n%estigate dominant #rms P 40I market share

;n%estigate restricti%e practices: /artels'collusion & price #"ing or coordinated

in%estment

Mredatory * limit pricing

=estriction supply to distri!utors ull line forcing

/reation arti#cial entry !arriers & ad%ertising$ !randproliferation



C" Competition Policy .

;n 200<$ the uropean // instructedicrosoft to make freely a%aila!le someof its patented technical information tori%als6 The most likely eFect on themarket is to:

) increase concentration6

9 increase contesta!ility6/ strengthen computer patents6

D increase entry !arriers6

increase icrosoft1s pro#ts6




)n in%estigation into store cards !y the // in200+ found that most retailers ere chargingannual interest rates of 30I$ far greater than

the rate required to co%er costs6 The //proposed measures to reduce interest ratesand so make the retail store card market:

) less contesta!le6

9 more allocati%ely eCcient6/ more concentrated6

D more pro#ta!le6

less regulated6




;n Decem!er 2004$ the N // !lockedthe proposed merger !eteen the stateoned gas and electricity industries inrance6 The most likely moti%e as to

) ena!le !oth industries to achie%e S6

9 pre%ent a further increase in entry !arriers6

/ a%oid diseconomies of scale ith mergers6D increase pro#ts in !oth #rms6

protect producer surplus in each industry6



C" Competition Policy =

But larger 6rms




Promotecompetition so4

)llocati%e

eCciency * soloer prices

Mroducti%eeCciency * soloer costs

Qreater /S * noelfare loss

9etter choice

But larger 6rmscan4

Qenerate

economies of scaleand loer prices =ein%est pro#ts

into = * D

,dynamiceCciency.

atch largeo%erseas

competitors /rosssu!sidise

lossmakingser%ices'goods



C" Competition Policy <

Ealuation to consider4)rgue the opposite %ie6

Eo contesta!le is the market ;s there any e%idence thatcompetition can increase in shortrun

Eo do incum!ents respond Mricears or aggressi%e ad%ertising etc6



5" PriatisationEaluation to consider4)rgue the opposite %ie6Eo contesta!le is the market;s there e%idence that competition can increaseEo do incum!ents respond Mrice ars or aggressi%e ad%ertising etc6



5" Priatisation #

Priatisation is the transfer ofeconomic acti%ity out of the pu!lic

sector and into the pri%ate sector inorder to:

;mpro%e producti%e eCciency

;ncrease competition * loer prices

;mpro%e choice and quality

;ncrease inno%ation



5" Priatisation 0

The go%ernment appointed QoldmanSachs to sell oF Tote in )pril 20086 Toteons 540 shops %alued at A320 !n6 Themost likely reason to sell oF Tote is:) encourage more gam!ling6

9 reduce industry contesta!ility6

/ a%oid an T in%estigation6D achie%e !ene#ts from pri%atisation6 open up the industry to >hit * run@competition6



5" Priatisation 3

Public priate partnerships ?PPP@4

) partnership here pri%ate sector #rms deli%er

pu!lic ser%ices or proRects on !ehalf of thepu!lic sector6

Mu!lic sector operations are contracted out topri%ate #rms$ ho are more considered to !e

more eCcient and specialised at these ser%ices6 Competitie tendering introduces

competition !eteen #rms as they !id forcontracts$ thus dri%ing don costs6



5" Priatisation .

Priate :inance (nitiatie ?P:(@4

Mri%ate sector #rms #nance$ maintain andlease infrastructure ,hich as pre%iouslypu!licly oned and funded. to the pu!licsector6

"amples: etronet * ondon Nnderground

idland "pressay * + toll road

/onstruction of many prisons and 7ES hospitals



5" Priatisation

The bene6ts4 oer costs * greater

producti%e eCciency Nse of specialised #rms

can deli%er higherquality product

/onstruction ithin!udget * on time

ease reduces need forlarge pu!lic spending =isks of proRect

transferred to pri%atesector

But there are concerns4 ack of competition may

raise pri%ate pro#ts and

not !e cost eFecti%e /ost cutting can !e at

the e"pense of quality ittle risk as risk

ultimately lia!le on

pu!lic sector arge procurement *

administration costs Qo%ernments can !orro

more cheaply



E" Regulation



E" Regulation #

=egulation aims to mimic the eFectsof competition and so:

Nse price caps to keep prices lo nsure pro#ts rein%ested

nsure product and ser%ice quality ishigh through performance indicators

Take into account e"ternalities

Mromote competition



E" Regulation 0

Mricecaps:

=M;: >@ e"pected eCciencyimpro%ements

=M; - O : >O@ additional capital

e"penditure

=M; - : >@ reUects una%oida!le cost

increases



E" Regulation 3

Eousehold ater !ills are regulated!y fat according to =M; - O6 ;n

200<$ =M; as 36VI and O set at36(I6 This meant ater !ills) decreased in nominal terms !y 068I

9 increased in !oth real and nominal

terms/ increased !y no more than the rateof inUation e"cluding mortgage

repayments



E" Regulation .

)n ad%antage of using =M; & to regulate apri%atised monopoly is it allos the #rms to) raise prices !y less than mortgage interest

payments9 keep supernormal pro#ts achie%ed !yadditional eCciency impro%ements/ raise the price of goods the #rm does not

e"portD makes only normal pro#ts do no more than !reake%en



E" Regulation

fcom ended more than tenty years ofprice controls for telephone calls on 9T in200+6 The most likely reason for this is that

) 9T is no longer required to raise prices !yless than mortgage interest payments9 pro#t capping is ineFecti%e in protectingconsumer interests

/ 9T1s prices ha%e increased a!o%e inUationD signi#cant competition no e"ists technological change is set to increase



E" Regulation =

Wu6 "amine the likely impact of price capsLL6

De#ne price caps

Nsed to regulate natural monopoliesL66 Types of price caps used)nalyse the !ene#ts: ;ncrease producti%e eCciency

oer real prices Mre%ent pro#teering at consumer1s e"pense

und necessary in%estment

5 year price caps allo planning ahead



E" Regulation 1

Wu6 "amine the likely impact of pricecapsLL6

%aluation: =egulatory capture

)symmetric information

Mro!lems of setting price caps & regulatoryfailure

=isks of une"pected shocks ,although =M; - .

/omparison ith other types regulation



E" Regulation <

Wu6 "amine the likely impact ofperformance targets on LL6

De#ne performance targets & regulatoracts as surrogate competition by tryingto improve standards of customer

service)pplication to data or e"amples & next

day delivery targets for Royal Mail ornumber of trains on time



E" Regulation D

Wu6 "amine the likely impact of performancetargets on LL6

7eed to increase in%estment

but higher SR costs or into wrong technology ;ncrease allocati%e eCciency

but at expense of higher prices7eed to change orking practices

but can have problems with trade unionsay loer producti%e eCciency

but investment could deliver LR improvement ay reduce pro#ts

but not if already meeting targets



E" Regulation #

;n the NS$ limits ha%e !een placed on pro#ts ofpri%atised utilities relati%e to the %alue of theircapital assets6 Bhat are the disad%antages of

,rate of return. regulation) irms ill under%alue their capital

9 Wuality may decline as the regulator forcescosts don/ irms can make unlimited supernormal pro#tsD irms ha%e little incenti%e to !ecomeproducti%ely eCcient irms are encouraged to make e"cess pro#ts topay out as di%idends to shareholders

Unit 3 Revision ALEVEL

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